If you’re a small business owner, you know that financing your business can be a challenge. Whether you’re seeking investors or applying for a commercial mortgage loan, you’ll need to be prepared to prove that your business is viable.
At Addition Financial, we work with our business members every day to help them obtain the financing they need, including commercial real estate loans. We are often asked about commercial mortgage rates and how to evaluate them. In other words, are you getting a good commercial mortgage rate or not? Here’s what you need to know.
What to Consider When Shopping for a Commercial Mortgage
Buying commercial property nearly always requires a commercial mortgage, since few businesses have enough cash on hand to buy a property without one. Here are some of the factors you should consider as you review lenders and shop for a commercial mortgage:
- Your ability to make a down payment. In most cases, a commercial lender will expect a down payment of 20%, although there are exceptions. You’ll need to be sure you have enough cash on hand to make a substantial down payment.
- Your ability to pay closing costs. Just as would be the case with a residential mortgage, you’ll pay between 2% and 5% of the purchase price in closing costs.
- The financial picture of your business. You’ll need to have your financial ducks in a row before you apply. You’ll be expected to provide financial statements, profit and loss reports and copies of your business bank statements and tax returns.
- Economic conditions. The Federal Reserve sets interest rates and may raise or lower them depending on how the economy is performing. Economic conditions such as inflation may impact interest rates.
- Loan types and options. Commercial real estate loans are available from credit unions and banks. Some loans are also backed by government agencies including the Small Business Administration (SBA) and the United States Department of Agriculture (USDA.)
For the underwriting process, you’ll need to provide documentation to prove that your business – and the property you’re buying – can generate enough income to make the monthly payment on the loan.
How Are Commercial Mortgage Rates Decided?
Commercial mortgage rates are decided using a variety of factors that include economic conditions and the applicant’s credit history and ability to repay the loan.
The basis for every commercial mortgage rate is something called the overnight bank funding rate, which is set by the Federal Reserve. The rate is calculated using federal funds transactions and other factors.
The overnight bank funding rate is something lenders use to determine the prime rate; in many cases, they simply add a predetermined percentage to the overnight rate. Lenders often use the prime rate for their most creditworthy customers.
Other factors that may impact commercial mortgage rates include the following:
- Your business financials
- Your business credit score
- Your payment history
- Your personal credit score
- The income-generating ability of the property you’re buying
You will have the best chance of qualifying for a low commercial mortgage rate if your business is financially strong with high credit scores, and when the property you intend to buy with the mortgage is likely to generate enough income to pay your monthly debt service.
What Are Typical Fees for a Commercial Mortgage?
Commercial real estate loans may sometimes have lower interest rates than residential mortgages. They also come with closing costs, which may total between 2% and 5% of the loan amount. Some of the fees depend upon the location of the property you’re buying and what you intend to do with the property.
Loan Origination Fee
The loan origination fee is determined by the lender and typically ranges from 0.5% to 1% of the loan amount.
Brokerage Fee
If you work with a broker to locate a property to buy, then the brokerage fee will be your responsibility. It is often a fixed percentage of the purchase price but in some cases, it may be determined using another formula.
Appraisal and Inspection Fees
The appraisal is required for the underwriting process and will typically be ordered by the lender and paid for by the borrower. Inspections are usually arranged and paid for by the borrower. Rates may vary based on the size of the property being inspected and who you hire.
Third-Party Fees
Lenders may require additional reports or inspections by third parties, Here are some examples:
- Phase I/II environmental reports
- Zoning report
- Engineering report
- Seismic report
Some of these may not apply to you. For example, a seismic report would be required only if the property being purchased is in an area that’s prone to earthquakes.
Additional Fees and Costs
There are two additional fees you should know about. The first is related to the title of the property. Your closing costs will include a title search and we also recommend buying title insurance.
If you hire a lawyer to help you through the process of buying commercial real estate, you’ll also need to factor in legal fees. These are not included in the closing costs but will be your responsibility.
Can You Get a Fixed Rate on a Commercial Mortgage?
One of the questions we are asked most frequently about commercial real estate loans is whether it’s possible to get a fixed rate loan to buy commercial property. The short answer is yes, but it’s not always possible.
Many commercial mortgages have a variable interest rate. It is common to have a fixed rate for the initial period of the loan, after which the interest rate may vary based on economic conditions. For example, you might have a fixed rate for the first five years of your loan and then switch to a variable rate.
There are commercial loan programs that offer fixed rate mortgages to buy commercial real estate. An example is the SBA 504 loan program. This program provides long-term, fixed-rate mortgages for “major fixed assets that promote business growth and job creation.” They are available through Certified Development Companies, or CDCs, community-based partners of the SBA who promote economic development in their communities.
Most credit unions and banks do not provide 30-year fixed mortgages, which are the most common type of residential mortgage. They don’t have the option of selling commercial mortgages to Fannie Mae or Freddie Mac, which means they shoulder the risk and are less likely to be willing to lock in an interest rate.
On a related note, you should know that another common feature of commercial mortgages is a balloon payment. That’s because while commercial mortgages may have a 30-year amortization period, they do not have a 30-year loan term. At the end of your loan term, which may be 15 or 20 years, you will be responsible for a balloon payment to pay the remaining amortization.
Tips to Get the Best Commercial Mortgage Rate
Here are some tips to help you get the best possible commercial mortgage rate:
- Do the necessary financial prep work. While the basis of commercial mortgage rates is set by the Federal Reserve, underwriting has the biggest impact on what your loan rate will be. You’ll need to prepare financial reports for your company and review them to make sure you have the resources and income to make monthly mortgage payments.
- Improve your business credit. Most lenders use the FICO Small Business Scoring Service (SBSS) to evaluate business credit. You’ll need a minimum score of 155, and if your score is higher than that, you’ll be in a position to get a favorable interest rate.
- Get your personal credit in order. It’s not uncommon for commercial lenders to require a personal guarantee on a commercial loan. Your FICO score should be at least 660, and with a higher score, you will be most likely to get an advantageous rate.
- Save for a down payment. While it’s sometimes possible to purchase a commercial property with a down payment of less than 20% of the purchase price, most lenders prefer 20% or more. Making a larger down payment can help you qualify for a better interest rate.
- Understand the income-generating potential of the property. The debt-service coverage ratio (DSCR) measures whether the property can generate enough income to pay for the monthly debt service of your loan. Typically, you want a DSCR of 1 or higher to qualify for a commercial mortgage, with many lenders preferring a DSCR of 1.25 or above.
- Research lenders and loan programs. A big part of getting the best rate for a commercial mortgage is to know which programs are available to you. For example, if you meet the qualifications for an SBA 504 loan, you can get a fixed rate mortgage.
As you can see, all of the work you’ll need to do to get a good commercial mortgage rate happens before you apply. If you take the time to get your financial house in order and save for a substantial down payment, you’ll have the best possible chance of getting an advantageous rate for your commercial real estate loan.
Getting a good commercial mortgage rate requires preparation and research. The information we’ve provided here will help you prepare for the application process and be in a position to get the most favorable interest rate possible.
Are you looking for a commercial mortgage lender with competitive rates? Addition Financial has what you need. Click here to learn about our business loans and begin the application process.
Posted on Nov 16, 2022
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